Question #29
Reading: Reading 12 Evaluating Quality of Financial Reports
PDF File: Reading 12 Evaluating Quality of Financial Reports.pdf
Page: 23
Status: Incorrect
Correct Answer: A
Your Answer: C
Question
With regard to specific measures to analyze in detecting manipulation in the financial reporting process, which of the following statements is the least accurate?
Answer Choices:
A. An increasing days’ inventory on hand (DOH) measure may be indicative of obsolete inventory
B. A decreasing days’ sales outstanding (DSO) measure may be an indication of lower quality revenue
C. Negative nonrecurring or non-operating items may be indicative of misclassifying an operating expense
Explanation
Days' sales outstanding (DSO) measures the number of days it takes to convert receivables
into cash and is calculated by dividing the number of days in the period by the accounts
receivable turnover ratio. An increasing DSO (decreasing receivables turnover) may be an
indication of lower quality revenue; that is, the longer it takes to collect from customers,
the more likely the receivables will turn into bad debt.
Days' inventory on hand (DOH) is equal to the number of days in the period divided by
inventory turnover ratio and it measures the number of days it takes to sell inventory. An
increasing DOH may be indicative of obsolete inventory.
Analysts should compare changes in the core operating margin over time and look for
negative nonrecurring (e.g., restructuring charges, asset impairments, and write-downs) or
non-operating items that occurred when the ratio increased. This may be the result of
misclassifying an operating expense.